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Taming Risk

One issue that should concern us all is the management of our investments. People constantly ask themselves if they are making the right decisions or if the composition of their portfolio is optimal.

It is worth mentioning that there is no single recipe, the tools available today will seek to manage investment portfolios taking into account factors such as customers’ and investment’s profiles, as well as market factors.

It is broadly known the linear relationship between risk and return, that is, a higher return is usually associated with greater exposure to risk.

From a theoretical stance, the optimal risk-reward relationship can be identified by Modern Portfolio Theory. This theory looks for a portfolio composition located on the efficient barrier, a curve described by the expected returns and associated risk of assets within the market.

Optimizing does not mean eliminating the risk or magnifying the return indiscriminately, it is looking for a balanced mix, based on the profile of the investor and the investment itself.

Can we eliminate risk? the answer would be “technically yes.”

Within the universe of instruments in which you can invest, there are some recognized as risk-free, that is, any other investment must grant a higher expected return. Globally, the United States treasury bond is recognized as the bearer of this designation.

However, risk is usually depicted as how much performance can vary (both upwards and downwards) against my expectations. In numerical terms it is defined as the standard deviation, which is a measure of the volatility in returns over time.

Tipping our toes in the philosophical field I would like to make an analogy.

A stress free life is a symptom of a happy life, tranquility being a consequence and not necessarily the ultimate goal. In other words, seeking to have an integral and balanced life, may eventually translate into that tranquility. I assume that exclusively focusing on replicating this manifestation, does not necessarily achieve lasting foundations.

In the same sense, the tranquility that we look for in our investments must be the product of a well executed plan and an “optimized” risk, not necessarily eliminated. Even if there are profiles that cheerfully accept an investment in risk-free instruments, it is worth discovering what would be the most efficient way, knowing what else could be adapted to our objectives, and being aware of the opportunity cost incurred.

The most important thing is that we stay committed to our goal, be aware of the risks associated with our strategy, and take control of our financial freedom.